By Mahmood Khaghani in association with Chris Cook

Iran at the crossroad of 1398 budget

December 5, 2018

TEHRAN - A journalist called me the other day and requested my opinion with regard to the next Iranian year 1398 budget that it seems the government considers oil prices will be higher than 50 dollars per barrel. I, in turn, asked a Senior Research Fellow at University College London about his prediction with respect to oil market during 2019. He said: "As a wise man said, "It is difficult to make forecasts, especially about the future."

I think he is right. Forecasting oil prices is notoriously difficult. However, some market trends are visible and providing us with signals which we need to notice.

Firstly, the long term trend, where forecasters such as the International Energy Agency and oil companies have for years assumed continually rising demand, prices and production. But as Sheikh Zaki Yamani said, the Stone Age did not end for lack of stones, and the Oil Age will not end for lack of oil, by which he meant that where one barrel of oil once fuelled extraction of maybe 50 barrels, now the ratio may be one to ten or even less in the Canadian tar sands. The outcome of this increasing energy intensity of oil production, and hence energy return on energy invested (EROEI) is that the oil price has reached a 'tipping point', at perhaps $50-60/barrel or so, where sheer lack of affordability makes substitution for oil by renewable energy, and investment in energy efficiency (‘Fifth Fuel') increasingly compelling.

Secondly there are medium term market price cycles, where prices rise to Seller's Market levels at which demand is choked off while new supplies come online until the market is oversupplied, and then collapse to Buyer's Market levels, where supply is choked off and demand rises until the market is under-supplied and so on. As has been said, the cure for high prices is...high prices and the cure for low prices is....low prices.

I think market observers and participants have become accustomed in the past decades to market power lying with the producer “sell-side”, and secondly, has come to believe that it is OPEC, rather than Wall Street, who controls prices. During the financial crisis the oil price gyrated in 2 years from $80 to $140 to $35 and back to $80 barrel while the physical oil supplies varied by less than 3%. While OPEC made increasingly panicked cuts, the true reason for these movements was financial. The reason for the spike was a financial bubble in prices funded by Wall Street, and the reason for the 2008 collapse was quite simply that while physical demand existed buyers were unable to access trade finance from banks to pay for oil.

What is now happening, according to Chris Cook, Senior Research Fellow at University College London, is that once again the oil market price has been inflated by finance capital, except this time we see consumers (the buy-side) react by attempting to seize market power. Mr. Cook points out that China saw their oil costs rise from mid-2017 by well over $100bn a year, while other Asian buyers (and the EU!) suffered proportionally. More to the point he observes that China has launched a new benchmark oil contract in Shanghai and has meanwhile built colossal storage capacity as well as very considerable export refining capacity. He believes that China is essentially sanction-proof and hence in a position to act as Buyer of last Resort, and then to undercut global market prices in gasoline.  

So I agree with Mr. Cook that we will, in the absence of U.S. adventurism in the Persian Gulf, see the market price of crude oil fall during 2019 below $50/barrel and stay there for some time.

How should Iran respond particularly with regard to its 1398 budget? In my view, Iran should, like Qatar, leave OPEC and commence to supply oil, (rather than sell it) to refineries in exchange for a supply of oil products. Or better still, instead of taking delivery of products, to accept in exchange Energy Credit Obligation (ECO), which would be credits issued by refiners and accepted by them from customers instead of U.S. dollars, euros or domestic currency. Unlike Venezuela's Petro such an ECO is not only based on useful products such as gasoline or diesel, but may actually be used to pay for them.

Mr. Cook highlighted an important fact for me that, such an ECO offers would be a simple but radical instrument for a subsidy distributed to Iranians as an Energy Dividend rather than current distributions of inflationary cash Rial.

In conclusion, I believe that a combination of energy swaps and ECOs could enable Iran to transcend sanctions and make the transition from the volatile & cyclical oil commodity market to a new global market in energy as a service.

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